Ruminations has been discussing what should happen when a tenant’s exclusive use right is breached. One of the remedies suggested in prior postings, as well in reader’s comments, is the tenant’s right to terminate the lease. That’s a remedy brought up in other contexts as well. So, it seems appropriate to discuss the “lease termination remedy” in a somewhat general way, not just when it come to exclusive use rights.
Many leases give a tenant the right to terminate the lease if some things go wrong, not just when anything goes wrong, but certainly when a listed condition occurs. To Ruminations, there are two categories of such things that can go wrong – those that are the result of a breach by the landlord, and those that are not the result of a breach by the landlord.
When a tenant gets the right to terminate a lease it may be “off the hook” when it comes to lease obligations (think, paying rent), but is also loses use of the premises. In some cases that’s good; in others, that’s not so good. More about that below.
Let’s talk about when a tenant uses lease termination as a remedy for its landlord’s breach. That may look like the mirror image of the remedy the landlord gets when its tenant breaches the lease – eviction or lease termination – but, not if it is the tenant’s sole remedy. After all, a landlord can evict its tenant and still chase its tenant for damages to make itself “whole.” If the tenant is only afforded lease termination as its “sole” remedy, it may not have been made “whole.” So, that’s rule one for tenants who are negotiating a termination remedy when the landlord has breached the lease – you need to reserve the right to avail yourself of your other lease and legal remedies, such as to pursue damages.
Now is time for an example. Please keep in mind that the following somewhat common provision in small leases, while very often the result of unequal bargaining power, shockingly it often results from ignorance. Picture a lease that says if the landlord fails to require later-in-time tenants to abide by your exclusive use rights, you, the tenant, as your sole remedy, may terminate the lease. So, you have the exclusive right to sell pizza in your 1,200 square foot store. Along comes a prospective national chain restaurant that want to sell pizza as a featured menu group. Your landlord thinks: “I get a big, secure tenant in that 7,500 square foot vacant space that has been sucking wind and my little pizza shop terminates its lease – ‘not a bad trade.’” So, your business drops 30% and, as your sole remedy, you terminate your lease. Feels great, doesn’t it? You’re saying: “look how smart I was, I got the exclusive right to sell pizza.” Yes, you are out of your lease, but you are also out of business. [By the way, a self-employed individual who loses a job because the business folded doesn’t collect unemployment insurance.]
There is a small glimmer of hope for the tenant who may be willing to risk the money. As we have ruminated in earlier postings, perhaps the landlord, in making the choice to deliberately breach its agreement that you will be the only seller of pizza at the shopping center, has also breached another lease provision. Which one, you ask? Try the covenant of good faith and fair dealing implied in every contract (and that includes leases). We’ve not yet seen that case, but we can’t figure out why not, except for the possibility that it costs a lot to prosecute such a claim as a case of first impression.
Now, when can the sole remedy of terminating its lease make sense to a tenant (or even a landlord)? We think it makes sense when the bargain reached between the parties can’t be realized because of an uncontrollable event. Give me an example, you say. Let’s say the tenant leased its space relying, in a measurable way, on the existing, unimpaired four-way access and exit from the property. Then, governmental authorities make the road into a divided highway and it isn’t very convenient to get to the shopping center any longer. Neither the landlord nor the tenant did anything wrong. Had the road been a divided highway at the outset, the tenant wouldn’t have gone there in the first place. [Don’t argue the facts, this is a reasonable hypothetical example.] Will the landlord be hurt if its tenant terminates the lease? Yes, but at least it still has an asset. The value of the asset may have dropped by reason of the impaired access, but that would have happened with or without the departing tenant in place. Plain and simple, in our hypothetical example the rent just became too high. The landlord can try to entice the tenant to stay by offering rent at the new, lower market rate, and the tenant might decide that it is worth its while to stay rather than to move. Basically, it would be looking at the space with fresh eyes, but it would be influenced by whether the good will it has garnered at that location tips the scales in favor of staying at the lower rent..
You can add you own examples, including the panoply of “contingencies” or “conditions precedent” we commonly see in leases. Most parties accept that if a certain list of conditions aren’t satisfied, the tenant can terminate the lease before it takes occupancy – things like failure to get approvals, failure to get a liquor license, lack of an SNDA, etc. Even landlords have such items, the failure of which to obtain would allow them to terminate a lease, such as failure to get a lender’s approval for the lease, inability to get an exclusive use waiver from another tenant or inability to get land use approval.
The examples in the paragraph above are pretty non-controversial, although often subject to intense bargaining. As to conditions that might come up after the lease has “started,” some are more controversial. In every case, the question is: “who should take the risk” of an event that wasn’t caused by either party – one for which no party would be expected to pay damages to the other. Some examples – a taking by eminent domain (even just of significant parking), fire (beyond a certain time threshold to restore the premises or the balance of the buildings), environmental stigma, loss of a specified number of key tenants or development of a major, adjacent competing shopping center. This isn’t a one way street. Landlords may want (need) the right to terminate a lease if really bad things happen warranting redevelopment of the shopping center for non-retail use. Yes, perhaps if occupancy drops below a certain amount, the landlord should have the right to terminate a lease (with or without payment) if terminates all other leases and agrees not to redevelop as a retail property for (say) five years.
Can we sum this up? We’ll try. When one party breaches its lease obligations, the other party should be entitled to be made whole. Depending on how fundamental the breach is to the usefulness of remaining at the property, a tenant may also deserve the right to cut its losses and get out of its lease. That should be a choice, not a required or sole remedy. That’s just like what a landlord typically gets. A landlord can choose to evict or not and still retain the right to be compensated by its tenant for damages.
If nobody is at fault, but the bargained for deal really, really doesn’t work because of an uncontrollable event, then the damaged party should be able to cut its losses. Usually that translates to allowing the tenant to choose between going and staying because the landlord still has the property and its diminished value was a feature of the property, not a feature of the lease.
Of course, just like in tax matters where everything is deductible until audit, in leases everything is subject to bargaining and affected by the relative bargaining powers of the parties at the time a lease is signed.